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Sources and practicality of momentum profits: evidence from the UK market

Abstract

It is hard to believe that rewarding opportunities in a liberalised market are left unexploited by acquisitive market participants or even by proficient institutional investors. Notwithstanding this, the sources of momentum profits have been puzzling academics for many years. Therefore, the incentives for these rewarding opportunities remain an unresolved mystery long after the momentum phenomenon has been identified. The significance of the momentum phenomenon is reflected in the voluminous studies that investigate it. This thesis aims to investigate a number of issues surrounding the debate on the momentum phenomenon in order to provide a broader understanding of the profitability of momentum strategies and its sources by using alternative as well as some new methods. Furthermore, this study investigates momentum strategies in the UK market by controlling for several market microstructure effects and finds that momentum profits tend to disappear after the six months holding period, from the year 2000, providing evidence of fading momentum profits. While market states fail to explain fading momentum profits, this study argues that it is the result of gradual market awareness. Seasonal effects on momentum returns after 1998 show evidence of continuing tax-loss selling activity, and hence, draw impactions on the effectiveness of the governmental 1998 Tax-Act. This thesis also supports the presence of an industry effect on the cross-section of momentum returns; however, this effect is small and is confined to the stocks that have performed well in the past and increases with liquidity. Empirical evidence suggests that momentum profits exist among the highly liquid stocks that are weekly traded. The findings also suggest that market frictions such as short sales constraints and trading costs cannot eliminate momentum profits among optioned or non-optioned (comparable) stocks using a new technique to measure transaction costs. The overall evidence implies that the observed momentum profits are not fully attributed to the argued trading obstacles but mainly driven by biased investment decisions and that momentum profits are significant even after controlling for uncertainty, ambiguity and trading costs